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Submitted by: Bill Brennan and Michael Byman
Bill owns Capital Management Group, LLC. He has more than thirty years experience as an advisor on personal finances, taxes and investments. Bill has been recognized by Washingtonian magazine and other publications as one of the top financial advisors in Washington, D.C. Michael handles business development for Capital Management Group, and is currently pursuing his CFP designation.
Here’s a brief “ETFs 101” primer to illustrate why our firm has placed ETFs at the core of our investment strategy.
ETFs first arrived on the scene with the introduction of Standard & Poors’ Depositary Receipts (SPDRs) in 1993. As of the end of November 2006, the Wall Street Journal counted 315 to choose from, with total assets increasing by 29% in 2006 to $383.3 billion. And the growth continues to accelerate.
ETFs are different from traditional “actively-managed open-end mutual funds” in some important ways:
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ETFs are index funds, emulating the composition and performance of pre-established market segments. Common indexes tracked by ETFs include large, mid and small-cap US stocks; developed-market or emerging-market international stocks; industry sectors such as technology, biotech, energy or utility stocks; and – most recently – commodities.
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Rather than buying and selling shares from investment companies at the end of each day, investors buy and sell from each other on stock exchanges throughout the day. This creates stock-like capabilities such as the use of limit orders, put and call options and short-selling.
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Because the ETF manager’s primary role is adhering to an index rather than researching stocks and moving them in and out of the portfolio, annual expenses are extremely low – generally between 0.1% and 0.5% per year as opposed to an average of about 1.3% for mutual funds.
These features produce some simple but profound portfolio management benefits:
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Precise, low-cost diversification. With full transparency into each fund’s composition, and no risk of “style drift” common with mutual funds, one can assemble a portfolio of ETFs that are complementary rather than redundant.
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Tax efficiency. The structure and portfolio management process of ETFs minimizes exposure to the dreaded year-end capital gains distributions that afflict mutual fund owners.
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Risk management. The performance of an ETF should always approximate that of its benchmark. Plus, indexes are much less volatile than individual-company stocks.
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Flexibility. The current assortment of ETFs enables the creation of unique investor-specific portfolios, and the trading capabilities offer more latitude to get in or out of positions at a desired time or price.
Within our practice, we specialize in ETFs because they enable us to do our job better. They help us minimize investment expenses for our clients. They allow us to devote more of our resources to constructing and managing individualized portfolios for each client, and addressing our clients’ personal financial concerns. By combining ETFs and active managers in a “core and satellite” investment model, we can concentrate on the relative handful of managers who have shown a unique ability to out-perform their benchmark (or “deliver alpha,” in industry jargon) at a reasonable cost.
We believe ETFs will continue to evolve into the foundational investment vehicle for individual investors.
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Authored by the
founder of the
PaladinRegistry